Various emotions are experienced as a trader holds onto a ticker through the various stages.
Stage 1 – Accumulation. Stock is quiet, trading sideways and without a lot of volatility. Most everyone ignores the stock because it has no sizzle. Insiders hold large blocks of stock and quietly gear up for the distribution.
Stage 2 – Breakout. Volume jumps up, psychological barriers are broken. Insiders begin to tell their friends of upcoming significant fundamental change. Pros take notice and buy the stock on the coat tails of the well informed. The public ignores it because they have not read about the company in the paper yet. It must be a scam.
Stage 3 – Uptrend. As a larger audience learns of the company and its promise, more buying comes in to the stock and it begins to climb. Pros begin to sell, but slowly. Average investor begins to buy.
Stage 4 – Pullback. The stock has gone up too fast, and some profit taking arrives. The jumpy investor who got the entry timing right but lacks confidence in his or her decision sells the stock with a small profit, and smiles in the mirror. The Pro holds on, Average Investor looks through the newspaper to find justification for ownership of the shares.
Stage 5 – Resumption of the Uptrend. The pull back is short lived, and the stock bounces and continues higher. The wannabe regrets the sell, but provides self counsel on the merit of making a profit, albeit a small one. The Pro might sell a little bit more, but still holds the majority of the original position. The Average Investor is getting excited now, and thinks about what could have been if only he had bought when he first noticed the stock.
Stage 6 – Exhaustion of the Uptrend. The media takes notice, and communicates the company’s merits to the masses. The masses buy the stock, and it goes up sharply with strong volume. The Pros sell with enthusiasm. The Average Investor owns it now, and is telling everyone who will listen. The wannabe Pro jumps back on, after all, he was smart enough to buy it when the trend started, so he knows the stock well. Will hope make it go higher?
Stage 7 – Gravity Works. Pro selling begins to weigh on the uptrend, and the stock fails to go higher despite high volumes. The stock starts to go down instead of up, and the Pro is almost sold out. The Average Investor continues to cheer lead, hoping to rally support. The wannabe ignores what the market is telling him, taking a loss is too painful to consider. The company is featured on the cover of a magazine.
Stage 8 – The Second Guess. The stock bounces and starts to go back up. The wannabe Pro averages down while the Average Investor gets back to advising friends of his stock picking acumen. Pros sell their remaining holdings and begin to look for another deal to play, or perhaps start short selling the stock.
Stage 9 – Out of Gas. The bounce is a fake out, and the stock moves lower again. The public own this stock, and they have no more power to buy. The Pro are making money on the short sales now, but are despised by the masses. Calls for short selling to be made illegal are made by the Average Investor, after all, the short sellers are the demons causing the sell off.
Stage 10 – Dead Cat Bounce. The Average Investor and the wannabe Pro have no pain tolerance left, and finally sell for a big loss. The short selling Pros are the only buyers to take the share off their hands, and provide the needed liquidity. The stock bounces, and some short term traders make a quick profit. The Average Investor either swears to never buy a stock again, or tells lively stories over drinks about the one that could have been.
Stage 11 – Post Mortem. Pros have forgot about the stock and are considering carpet samples for their new home in Florida. Average Investor continues to follow the company and buys loads of cheap stock to try and overcome the regrettable loss.
The stock market is mean. You can be a good analyst, but if you can’t overcome the psychological traps of trading, you will do what the crowd does. To be successful, you have be one step ahead of the crowd, and trade with unemotional discipline. There are strategies to take advantage of each stage of the marketcycle that can be applied just by looking at a stock chart. They just require a bit of knowledge.
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